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Pullback in risk on – and that’s a good thing

De-risk! The market pulled back today on expensive tech stocks, overstretched valuations, with investors questions whether the stock market still has legs.

Broad Pullback

Steep valuations forcing a pullback

The FAANG stocks took the biggest hits as investors start to question their lofty valuations. Facebook and Apple are currently trading at 37 times price to earnings, with tech companies such as Salesforce and Zoom trading over 100 times their valuation. However, some consider this a healthy thing for the markets. Alec Young, chief investment officer at Tactical Alpha LLC, stated that “Frankly, the deeper the pullback in tech, the healthier it is for the overall market.” He further noted that the “market was overbought; too many people chased the tech names. It is all Healthy; the valuations have been stretched.”

U.S Dollar seeing gains on a pullback

The U.S dollar is set to record a weekly gain after a near ten-week downwards spiral for the greenback. However, with the Federal reserve continuing to pump liquidity into the markets, there are still plenty of headwinds against the U.S Dollar.

Take advantage of the pullback.

If you are an investor, try not to look at your investments to prevent any impulsive actions. Use this opportunity to buy your favorite stock for cheaper. Remember, this is a marathon, not a sprint.

QQQ x GLD – The perfect portfolio?

Take a look at this chart:

Gold in Blue, NASDAQ in Yellow. For reference, QQQ refers to a well-known NASDAQ ETF, and GLD refers to a well-known Gold ETF

If we ignore the dip during the peak of the Coronavirus lockdowns, both have experienced high double-digit returns for the year. The NASDAQ and Gold have returned around 30% Year to date – and it is only mid-August. For reference, the NASDAQ returned 37% in 2019 – and that was before the pandemic.

There has been this interesting correlation between Gold and Equities recently, with both rallying in risk on situations. To explain this, we should look at the principles behind the 60/40 stock and bond portfolios.

Old fashioned 60/40 stock and bond portfolio lagging behind

The fundamental premise behind a 60/40 stock and bond portfolio is that bonds are supposed to be the ballast for stock when they dive. Stocks retract in risk-off scenarios, demand for safe assets such as bond increase. However, with real interest rates at 0% or lower, yield in bonds has matched the return in holding straight cash – even falling behind with real negative yields.

However, recently we have seen that both Gold and Equities have been rallying in unison – with a pullback in stocks further pushes higher.

There has been a saying that diversification is the closest to “having your cake and eating it too” in investing. However, with the Coronavirus pandemic and current macro environment, this may be your best shot in hedging your portfolio while maintaining strong equity-like returns.

Is Gold a safe haven or a bullish bet in a portfolio?

We’ll take a look at the first half of the equation: Gold.

Two things have been fueling a push higher in Gold. First, many investors and traders believe that Gold is a safe haven with no actual fundamental basis. They think that Gold will rally when there are risk-off periods in the market. Therefore, inflows in gold increase when equities dip.

Secondly, many investors believe Gold is a good investment when inflation and bond yields are low. This is because they think that they may attain higher returns from Gold while retaining that “safe haven” status bonds have. Furthermore, there has been a historical correlation between a weaker dollar and a stronger price in Gold. Therefore, there have been constant inflows throughout the year as the dollar weakens, and inflation comes into question. We can see that inflation-protection trade in the lower bond yields for Treasury Inflation-Protected Securities (TIPS) – with the Barclays 1-10 year TIPS ETF up around 5.6% year to date.

Barclays 1-10 Year TIPS ETF gaining traction

NASDAQ being a staple in many portfolios

Now we have the NASDAQ. There is nothing new with the NASDAQ trade. FANG has dominated the rise in the Index, with everyone staying at home and using their services. It is important to note that Facebook and Google are operating using an advertising model that offers its services for free in return for advertisement eyeballs. That is why they have been able to rise to the top, beating analyst estimates during the Coronavirus pandemic. With fortress balance sheets, they, too, have turned into a safe haven trade while retaining their growth status.

Analysts might argue that this space has been an overcrowded trade and that soon we will see the switch into cyclical and value such as energy and financials. However, the difference between tech and value is that tech continues to generate free cash flow today. Financials and Energy (ehem. Oil companies) are having a harder time.

The pandemic has forced macro-economic conditions around the world, which have been the perfect breeding ground for the tech and gold trade. The pandemic has forced people into their houses, relying on technology to connect them with the rest of the world. Furthermore, the pandemic has also forced governments and central banks to implement drastic measures to keep the economy afloat. This has lowered the need for investors to have that bond ballast in their portfolio, as there are safer assets that thrive in the current financial macro environment we currently find ourselves in.

I can’t give advice on the articles I write. However, I can see that I currently hold both stocks in QQQ alongside a generous holding in GLD ;)

Anish Lal, a senior analyst at BlackBull markets, made an excellent technical comparison between the NASDAQ, Gold, and the U.S Dollar. You can watch it here.

Safe trading!